Zynga Flashes $1.8 Billion Searching for the New FarmVille: Tech

Zynga Inc. (ZNGA) merger chief Barry Cottle plans to step up the pace of acquisitions, spending hundreds of millions of dollars in search of a new social-gaming blockbuster on par with hits “FarmVille” and “CityVille.”

The biggest maker of social games paid $180 million last month to acquire OMGPop Inc., after spending a combined $147.2 million for 22 companies in 2010 and 2011. Chief Executive Officer Mark Pincus expects to do “a few” deals the size of OMGPop or larger in the next three to five years, he said in an interview at the company’s San Francisco headquarters.

“We love finding great, accomplished teams that share our mission and vision,” Pincus said. “If we ever see breakout opportunities that massively accelerate social gaming at Zynga, we’ll aggressively pursue those, too.”

In its first year as a publicly traded company, Zynga is turning to M&A to expand into new regions and markets such as mobile games. Led by former Electronic Arts Inc. (EA) executive Cottle, Zynga’s retooled acquisitions team is working to speed up its deal-making process, outbid rivals on price and do a better job of keeping the talent it purchases. Their objective: injecting more high-growth hits like OMGPop’s “Draw Something” into Zynga’s portfolio of games.

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Zynga Inc. employees through the "time tunnel" at the company's new headquarters in San Francisco on March 15, 2012. Close

Zynga Inc. employees through the "time tunnel" at the company's new headquarters in San... Read More

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Photographer: David Paul Morris/Bloomberg

Zynga Inc. employees through the "time tunnel" at the company's new headquarters in San Francisco on March 15, 2012.

“We’re sitting in a very advantageous position,” Cottle said in an interview. “We have a significant amount of cash, we have no debt, and we have access to debt to be as aggressive as we need to be.”

Zynga has $1.81 billion in cash and short-term investments. The stock fell 5.8 percent to $10.31 at the close today in New York.

Bigger Targets

Going after more-established targets that are popular with users and generating revenue is a shift for a company once known for buying small and relatively unknown teams of developers, said Nabeel Hyatt, a former entrepreneur who sold Conduit Labs Inc. to Zynga in 2010 and is now a venture partner at Spark Capital.

“The mandate for Barry is to go acquire not just teams, but products that are having an impact in the market,” Hyatt said. “That’s a whole new ballgame at Zynga. It’s a different skill, and we will see how good Zynga is at it.”

So far, the game maker has failed to keep much of the top talent it has acquired. Founders from at least six startups have already left Zynga. That includes Hyatt, who left earlier this year. Roger Dickey, who founded the popular “Mafia Wars” franchise after Zynga acquired his startup in 2008, left the company last year.

‘High Accountability’

“The culture of Zynga is not for everybody,” Hyatt said. “It is a culture of very high accountability.”

A majority of the founders of acquired startups, including those not publicly disclosed, still work with the company, Pincus said.

Cottle, lured from Electronic Arts in January by a compensation package worth more than $25 million, has a track record in digital gaming. Over the past five years, he helped Electronic Arts become a leader in mobile gaming, and, through the company’s $400 million acquisition of Playfish Inc. in 2009, No. 2 in social games.

Cottle’s poaching is the latest salvo in an escalating face-off between the two game makers. Zynga has hired Electronic Arts veterans, including its chief operating officer and Cottle’s boss, John Schappert. EA has spent heavily marketing social games like “The Sims,” and last year outbid Zynga to acquire “Plants vs. Zombies” developer PopCap Games Inc. for as much as $1.3 billion.

Facebook Reliance

Both Zynga and Electronic Arts make free games played on Facebook Inc. (FB)’s social network. They generate revenue by selling virtual goods within the apps -- say, a gun in “Mafia Wars” or a tractor in “FarmVille.” Zynga, which makes more than 90 percent of its sales through Facebook, is working to decrease that reliance by offering games on social sites, including Google Inc. (GOOG)’s Google+, and on mobile devices.

Photographer: Simon Dawson/Bloomberg

Zynga Inc. Executive Vice President of Business and Corporate Development Barry Cottle in London. Close

Zynga Inc. Executive Vice President of Business and Corporate Development Barry Cottle in London.

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Photographer: Simon Dawson/Bloomberg

Zynga Inc. Executive Vice President of Business and Corporate Development Barry Cottle in London.

Since joining Zynga, Cottle has helped refine a deal-making process that once consisted of a handful of business-development managers sharing a single spreadsheet of more than 400 prospective targets. Now the company brings human-resources executives to meet acquisition candidates, asks its technical staff to look for potential snags in technology and deploys Pincus to convince startup founders that Zynga is entrepreneur- friendly.

“We pride ourselves on being able to move fast,” Cottle said. “Not because we’re not thorough, but because we have a pretty strong playbook when it comes to doing acquisitions.”

‘The Fixer’

Zynga’s thoroughness was on display last month in New York, where OMGPop CEO Dan Porter hosted Guru Gowrappan, Zynga’s head of M&A integration, who the company sends in to ease the assimilation process. Nicknamed “The Fixer,” Gowrappan helped Porter find answers to a variety of issues, from how to set up his employees’ COBRA health benefits to getting Android-powered handsets to use for software tests.

“He had this encyclopedic knowledge of every division in Zynga, and just routed us,” Porter said.

After acquiring startups, Zynga says it tries to preserve rituals that were important to individuals and teams -- for example, maintaining a no-meeting policy on Wednesdays at Newtoy Inc., acquired in 2010, and keeping a weekly stand-up comedy show that the team at Conduit Labs started prior to getting bought by Zynga.

“We bring a ton of people in to listen and understand what’s really religious about their organization,” said Cottle. “It’s important that the secret sauce does not change after they become a part of Zynga.”

Offering Stock

To help persuade entrepreneurs to stay, Zynga offers stock units that vest over two or more years. Unlike many Silicon Valley acquirers, the company typically doesn’t structure deals around performance incentives, or so-called earn-outs, which reward founders with extra cash or stock after their product gains a certain number of users, hits a revenue goal or meets some other business objective.

“I do not like earn-outs,” said Colleen McCreary, chief people officer at Zynga. “They encourage people to be individual-first. Using equity that is spread out over a couple years is a much better way” to get entrepreneurs aligned with the rest of the company, she said.

About 17 percent of Zynga’s 2,846 employees were brought on through acquisitions, McCreary said. That number has barely budged in the past three years, she said.

Deal Competition

As Zynga sets its sights on bigger targets, it’s encountering more competition. To buy OMGPop, it fended off competing acquisition overtures from Electronic Arts, Walt Disney Co. (DIS), Gree Inc. (3632) and DeNA Co., according to a person with knowledge of the negotiations, who asked not to be named because the matter is private.

To close the OMGPop deal, which took just two weeks, Cottle relied on one of his best weapons: Pincus. Zynga’s founder and CEO met with Porter in San Francisco and convinced him that his company supports the entrepreneurs it acquires by giving them freedom to make the games they want.

“I felt like, if I had to own stock in all the companies we are talking to, this is the one I would want to own stock in,” Porter said.

Zynga’s fast action was also helped by the fact that Pincus gained added influence over key decisions through a stock structure that gives him 36 percent of voting power.

“We avoid a lot of steps and cycles that other public companies have,” Pincus said. “We’re able to bring the board along with us very quick.”

Representatives of EA, Disney, Gree and DeNA (2432) declined to comment.

Question on Price

OMGPop was also won over by Zynga’s willingness to spend. Though its “Draw Something” app was making about $250,000 per day, according to the person familiar with the company, analysts say its future revenue potential may not merit the takeover price.

“I question the price they are paying,” said Arvind Bhatia, an analyst at Sterne Agee & Leach Inc. in Dallas. “If they have to every time go out and acquire the next number-one developer for $200 million, how long can you do that?”

Zynga’s new approach to deals came about after the company lost out on PopCap and at least three other potential acquisitions, according to people familiar with the negotiations. In 2010, “Rolando” creator Ngmoco LLC was bought by Japanese firm DeNA after Zynga’s talks with the startup failed to result in a deal. More recently, Zynga was turned away after attempting to buy HTML5 development startup Game Closure Inc.

‘Angry Birds’ Offer

Rovio Entertainment Oy, the Finnish maker of “Angry Birds” games, spurned Zynga’s offer of more than $2 billion, according to a person familiar with the company.

Representatives of EA, DeNA, Game Closure and Rovio declined to comment.

The company’s next targets are likely to be mobile-game makers, since it increasingly competes for the attention and dollars of gamers who download apps from Apple Inc.’s App Store and Google’s Android marketplace, said Michael Pachter, an analyst at Wedbush Securities Inc. in Los Angeles.

“They are not really that competent in mobile, and they need to be,” said Pachter, who rates shares of Zynga outperform and doesn’t own the stock. “It’s the way that a big chunk of the world accesses the Internet.”

Dani Dudeck, a spokeswoman for Zynga, declined to comment on potential acquisition targets.

One major mobile developer Zynga might be eyeing is ZeptoLab, because its hit mobile game “Cut the Rope” has consistently landed in Apple’s rankings of top apps, Pachter said.

Whatever companies Cottle tries to buy, he has set a precedent for paying top dollar, Pachter said.

“You are going to have a lot of developers swinging for the fences and trying to hit it fast and hope Zynga will give them a couple hundred million dollars,” he said.

To contact the reporter on this story: Douglas MacMillan in San Francisco at dmacmillan3@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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